Today I am republishing part of a series of articles I wrote back in May, 2008. Since then Wordout has added hundreds of new readers, and I hope they find this further insight helpful.
This was before Fannie and Freddie, before Lehman and the whole October surprise. But the general gist of it still applies.
Image via WikipediaThere Is No Spoon
Earlier, we looked into how much money there is in the world. If you took the time to watch that video, you probably came out of it with the only conclusion that was possible, which is this: There is no money in the world. There is only debt, promises to pay, IOUs. It’s hard to wrap your head around that, though, so it’s easy to look at all that debt the way we’ve been trained to: as if it were real money. Remember the main difference between “real money” and “Federal Reserve Notes” is only the difference between assets and debt.
But how, you might ask, if banks can create all the notes they want by creating debt, how could a bank ever go out of business? How could a banking behemoth such as Bear Stearns, be taken over for just a fraction of its current valuation? Well, they can only create those notes by creating debt. If there’s nobody left trying to get a loan, the bank simply has no way to create more debt. That’s essentially what happened to Bear Stearns. Nobody wanted their notes anymore.
Over most of the course of human history, the accumulated savings in fixed income securities of the world had built up to about 36 trillion dollars. Then, in the last several years, that figure nearly doubled to about 70 trillion. This is more than all the money spent by all the countries in the world in one year.
Much of this new wealth was stored up overseas, insane profits made recently by historically poor countries, cash made from the sale of oil and high tech items. The people in charge of managing all this new cash wanted to increase the returns on their investments. But they didn’t want to lose any of it. Normally, they would invest in treasury notes, or government secured bonds, something safe.
Think about it, there’s suddenly twice as much money to invest, and there’s just not that many great investments around. As if that wasn’t enough to cause the money managers to scramble, before he left, the great Alan Greenspan released a statement, which basically said that the US Federal Reserve funds rate would remain extremely low indefinitely, which made the treasury markets look much less attractive.
Mortgage Backed Securities
So these guys started looking for something that was still reasonably safe, but still more profitable. All they needed to do was beat the 1% from the Fed on Treasury notes, so even the low mortgage rates, around 5% on average, were very attractive. But these guys couldn’t manage a mortgage from around the world. Something new needed to be created.
So the Mortgage Backed Securities were created, and the global pool of money managers loved them. Individual mortgages were bundled together, and those bundles bundled and so on until enough mortgages were bundled together to sell for millions of dollars. That’s thousands of mortgages per package. For awhile, things were great.
But no market is endless. Eventually, everybody who could afford and qualified for a mortgage had bought one. By 2003, the market was starting to slow, but the demand for these types of securities was still insane. So looser guidelines were instated, making loans easier to get for slightly less qualified borrowers.
These new guidelines determined the loan an applicant could get, but in the end, literally anybody should have been able to get a mortgage. That was the so-called NINA loan, which is short for No Income No Assets, which means that there was no check run on you at all, except verifying that you had a credit score. (There were cases of loans made to dead people.)
Naturally, this makes absolutely no sense in the common use of the word. Why were the banks doing this? They were writing loans to people knowing in advance that these loans would default. Common belief is that the US housing market will never have a correction, that real estate values would only rise. Common sense says that no market can sustain endless growth. Corrections are a natural part of the cycle, like storms with the heat of summer.
So how did it happen? With all the computers and brilliant people on staff, why did they keep creating this bad debt? The answer is insidious. They were monitoring. They were watching these mortgages like a hawk, and all the data they had was positive. The projected foreclosure rates were capped at around 8-12% of these bad loans. The problem was, the computer programs used to analyze that data were wrong. The analysis used was the same as for the old-fashioned, Income Verified, Assets Verified, fixed-rate mortgages, and not for these new variations. In some areas the mortgage rates are now expected to go beyond 50% foreclosure rates.
This isn’t the end of the story. It actually gets a bit worse. So far we’ve seen that there isn’t really any money anywhere there are banks. We’ve also seen how the global pool of “money”, really just a collection of IOUs, doubled in less than a decade, creating a new investment market in the form of (mostly American) home mortgages. Click back to Wordout to learn how the crisis was guaranteed to happen by the use of neat little things called Collateralized Debt Obligations.
I am Jon, and right about now we are knee-deep in it.